State securities laws—generally referred to as “blue sky laws”— contain both registration provisions and antifraud provisions. Registration provisions require that a company offering its securities to investors in a particular state register its securities with the state or meet the requirements for an exemption from the state’s registration provisions. State antifraud provisions prohibit fraud in connection with the offer and sale of securities.
Blue sky laws – in particular, state registration provisions—have been a significant, unfair and inefficient impediment to small business capital formation. A small business offering its securities as a way to raise capital is required to meet the independent and separate registration requirements of each state (and territory and the District of Columbia) in which it offers its securities. A broad offering, therefore, may involve filing a registration statement (or qualifying for an exemption) under more than 50 separate and independent regimes
This amounts to an expensive and daunting task for a small business looking for external capital and generates no additional efficiencies or material investor protection. It is nothing short of bizarre to require a small business to meet the requirements of 50-plus separate and independent state registration regimes.
It has been difficult to remedy this problem and thus give the small businesses that are vital to our national economy fair and efficient access to the capital they need to compete and survive. States and state regulators have been tenacious in protecting their registration authority from federal preemption. The Securities and Exchange Commission, on the other hand, has been unwilling to promote any significant or efficient level of preemption of state registration authority.
Starting in the mid-1980s, scholars1 and ultimately the United States Congress focused on the problems wrought by state blue sky laws requiring registration of securities. This led to the enactment in 1996 of the National Securities Markets Improvement Act (NSMIA), wherein Congress, for the first time since the passage of the Securites Act of 1933, preempted some state registration authority.2
The most significant preemption by NSMIA was of state registration authority over Rule 506 offerings. NSMIA, however, fell far short of a complete relief for small businesses seeking external capital. For example, small businesses using Rule 506 are effectively compelled to limit the offering to accredited investors, which may amount to less than 5 percent of the total population.
The JOBS Act, which was signed into law in 2012, provides a new exemption from federal registration for so-called crowdfunding offerings.3 Stated generally and briefly, the crowdfunding exemption is available for offerings of up to $1 million made over the internet by companies that are not subject to the periodic reporting requirements of the Securities Exchange Act of 1934.
The JOBS Act and the Securities and Exchange Commission’s regulatory implementation of that act4 preempt state registration authority over crowdfunding offerings but impose burdensome and ambiguous requirements for the crowdfunding exemption. Most significant in that regard is that the crowdfunding exemption requires the issuer to file with the Commission and disclose to investors extensive investment information both at the time of the offering (ex ante disclosures) and on a periodic basis following the offering (ex post disclosures). The exemption also imposes strict limitations on advertising and traditional selling efforts and thus, as a result of the integration doctrine, limits (actually, prohibits) combining a crowdfunding exemption with another exemption (such as Rule 506 or Rule 147).
It was clear from the beginning that the requirements for the crowdfunding exemption would severely limit its appeal to the more than 5 million small businesses in the United States, notwithstanding the attractiveness of the preemption of state registration requirements. Preliminary data, unfortunately, show this to be the case. In the first eight months following the effectiveness of the final crowdfunding regulations, only an average of 26.3 crowdfunding offerings per month were filed with the Commission.5 In its present form, therefore, crowdfunding as a broad economic matter has amounted to virtually nothing. It is rarely used by the more than 5 million small businesses in the United States, nearly all of which at some point need external capital.
A similar fate appears highly likely for the new Regulation A rules,6 generally referred to as “Regulation A+,” which also were enacted under the JOBS Act. For small companies attempting to use Regulation A+, the most significant problem is that the Commission’s rules do not effectively preempt state authority over registration.
The Regulation A+ exemption requires the issuer to file with the Commission and disclose to investors a significant amount of investment information both ex ante and ex post. The amount of investment information is scaled according to the size of the offering. More information is required in Tier 2 offerings (offerings of up to $50 million) than in Tier 1 offerings (offerings of up to $20 million).
The Commission’s Regulation A+ rules preempt state registration authority over Tier 2 offerings but not over Tier 1 offerings. As a result, Tier 1 offerings would seem to have a quite limited appeal for small issuers seeking a relatively small amount of external capital, a logical assumption that once again is confirmed by early data on the use of Tier 1. Between the effective date of Regulation A+ (June 19, 2015) and January 19, 2017, there were on average only 5.1 Tier 1 Regulation A+ offerings per month filed with the Commission.
It is possible for small issuers – for example, those wishing to raise $20 million or less – to migrate to Tier 2. While this migration solves the small issuer’s state registration problems, it generates exceedingly more burdensome and expensive filing and disclosure requirements, which in most cases will practically foreclose small issuers from the Tier 2 option. Data, once again, show that a migration of an offering of $20 million or less to Tier 2 is rare. Between the effective date of Regulation A+ (June 19, 2015) and January 19, 2017, there were on average only 2.3 Tier 2 offerings per month for $20 million or less filed with the Commission.
The underuse of Regulation A+ by small businesses may be even better illustrated by looking at all Regulation A+ offerings (both Tier 1 and Tier 2) of $5 million or less, an amount of capital that may seem more in line with the needs of small businesses. Using again the same 19 month time period – June 19, 2015 to January 19, 2017 – on average only 2.8 offerings per month of less than $5 million were filed with the Commission. Again, unfortunately, these data show that Regulation A+ is essentially irrelevant to small businesses searching for external capital.
The net of this is that the registration provisions of state securities laws will continue to have a significant role regarding – and pernicious effect on – small business capital formation. Small businesses are barely using the crowdfunding exemption and the Regulation A+ exemption for Tier 2 offering, both of which preempt state registration authority. Limiting Rule 506 offerings to only accredited investors, which overwhelmingly is the case, eliminates perhaps 95 percent of the population from investing in the offering. Small issuers searching for external capital, therefore, are largely going to sell securities in transactions subject to state registration provisions.
In order to provide small businesses with a fair and efficient access to external capital, three changes are required.
First, Congress must preempt completely state authority over registration. Delegating power to the Commission to preempt state registration authority by regulation simply does not work. On two separate occasions – in NSMIA and in the JOBS Act – Congress delegated broad authority to the Commission to preempt state registration rules, and in each case the Commission failed in its duty to act in a way that significantly benefitted small businesses. History shows us, therefore, that only congressional action can effectively preempt state registration authority.
Second, the Commission must fix problems with both the crowdfunding exemption and the exemption provided by Regulation A+. These are fundamentally sound exemptions that if properly balanced could help markedly to improve the plight of small businesses in regard to access to external capital.
Finally, states, once stripped of registration authority, need to assume a role that will enhance an efficient allocation of capital. Specifically, states should enforce vigorously their state antifraud provisions regarding the sale of securities. Such enforcement will reduce the misallocation of capital by raising the penalty costs for miscreants who attempt to acquire investors’ capital by fraud.
1See, e.g., Rutheford B Campbell, Jr., An Open Attack on the Nonsense of Blue Sky Regulation, 10 J. Corp. L. 553 (1985).
215 U.S.C. § 77r (2016).
315 U.S.C. § 77d(a)(6) (2016); 15 U.S.C. § 77d-1 (2016).
417 C. F.R. § 227.100-.503 (2016).
5Data regarding crowdfunding and data Regulation A+, infra, were obtained from the subscription-only Lexis Securities Mosaic website.
617 C.F.R. § 230.251-.263 (2016).
This post comes to use from Rutheford B. Campbell, Jr., the Spears-Gilbert Professor of Law at the University of Kentucky College of Law. It is based on his recent article, “The Role of State Blue Sky Laws After NSMIA and the JOBS Act,” 66 Duke L.J. 605 (2016), available here. The author thanks Cody Barnett and Andrew Donovan for their assistance in the preparation of the article.